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Monday, April 26, 2021

Luxury Is Timeless

By Century Financial in 'Investment Insights'

Luxury Is Timeless
Luxury Is Timeless

*Trading in financial markets carries risk and can result in loss of capital

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The product and investment ideas do not consider the risk profile and financial position of the recipient and may not be suitable for everyone. Trading in financial markets and use of margin involves a significant risk of loss, which can exceed deposits. Please read the complete disclaimer carefully.

While stocks, like fashion, tend to go in and out of favor, the world's top luxury brands are made to last. The prime reason behind these brands' success is the massive barriers to entry on the supply side. Heritage is one of the many factors that have enabled the world's leading luxury brands to hold their region. Most of the top brands have their roots in France or Italy and have time on their side. Louis Vuitton, Cartier, and Hermes have been around for more than 150 years, while Gucci celebrates its centennial this year. Besides, a growing population of young, affluent consumers and the increasing social pressure continue to buoy Luxury goods' demand.

Historical analysis reveals that the luxury consumer is the most resilient and comes back after an economic downturn. The luxury shopper never really goes away; instead of picking five items, they probably buy two things. This behavior was evident even in the previous year, where luxury stocks staged a stellar rebound and outperformed the European benchmark indices. The same story was witnessed in the year of the financial crisis- 2008 and in the year 2009 when markets rebounded.

Riding The Luxury Wave With Pair Trading

One can participate in the luxury market while minimizing the losses through a pair trading strategy, which involves going long on the Luxury lifestyle share basket while simultaneously shorting the Euro Stoxx 50.

However, it is important to note that Trading pairs is not a risk-free strategy. The difficulty comes when the two securities prices begin to drift apart, i.e., the spread starts to trend instead of reverting to the original mean. Thus, it is essential to adhere to strict risk management rules when dealing with such adverse situations.

Strategy

The returns in the table below have been derived by undertaking long positions on the Luxury Lifestyle Share basket while simultaneously shorting Euro Stoxx 50 index. The exposure taken on the long side was equivalent to exposure on the short side. For instance: if $500K worth Euro Stoxx 50 index was sold, then simultaneously $500K worth Luxury Share basket was bought.

Over the past 13 years ending 2020, this strategy has resulted in total profits of 180% (with 2x leverage), with 12 years out of 13 years providing positive returns. The first Quarter of 2021 has also been profitable, with the strategy providing net gains of 3%.

Back-tested data based on the current index constituent weights.
Year Luxury Lifestyle Return Euro Stoxx 50 Return Long: Luxury basket Short: Euro Stoxx 50 (2x leverage)
2008 -37% -44% 8%
2009 37% 21% 16%
2010 48% -5% 53%
2011 1% -17% 19%
2012 32% 13% 19%
2013 12% 18% -6%
2014 6% 1% 5%
2015 11% 5% 6%
2016 12% 0% 12%
2017 24% 6% 17%
2018 -5% -15% 10%
2019 33% 26% 8%
2020 8% -5% 13%
Q1 2021 13% 10% 3%
Total 196% 14% 183%
Average yearly return 14% 1% 13%
  • The strategy has been back-tested on the current constituent weights, and hence the results are subject to backfill bias and selection bias.
  • Past performance doesn’t not guarantee future returns.
About Luxury Lifestyle Share basket

Luxury Lifestyle share basket is made up of 12 well-known brands within the luxury goods industry. These include companies that manufacture and retail fashion and beauty products, alcoholic beverages and luxury automobiles. Some of these luxury shares are seen as benchmarks for their industry, as they were established many years ago and have remained at the top of industry standards. This basket is not based around a particular country; instead, it features brands from significant European countries, such as Germany, France and Spain.

Individual stocks in the basket are subject to both weightage recalculation & re-composition risk. As a result, certain stocks may be added or removed from the basket as per the platform provider purview without any advance notification. This may be specific to any individual stock or due to any sector specific event. Consequently, share basket performance may significantly deviate from the one specified below.

Index Constituents

Bloomberg Analyst Recommendations
Company Name Current Weights Buy Hold Sell
Christian Dior 13.8% 0 0 0
LVMH Moet Hennessy Louis - - - -
Vuitton 13.4% 24 7 4
L'Oreal SA 13.1% 12 12 6
Hermes International 12.8% 4 13 3
Industria de Diseno Textil (Inditex) 12.2% 16 15 4
Porsche Automobil Holding 5.2% 11 5 0
Pernod ricard 5.0% 14 11 2
Remy Cointreau 5.0% 2 10 11
Kering 5.0% 22 8 2
Bayerische Motoren Werke (BMW) 4.9% 14 13 4
Daimler 4.9% 22 6 1
Hugo Boss 4.8% 7 15 4

Risks & Assumptions

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The strategy might suffer from look-ahead bias which occurs due to the use of information or data in a study or simulation that would not have been known or available during the period being analyzed. This can lead to inaccurate results in the study or simulation.
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Future price movements may not be exactly the same as the historical price movements and this could lead to variation in performance.
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Testing can sometimes lead to over-optimization. This is a condition where performance results are tuned so high to the past they are no longer as accurate in the future.
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The model assumes no slippages in trading. Slippage refers to the difference between the expected price of a trade and the price at which the trade is actually executed.
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Drawdowns in actual trading can be higher than the tested system and losses could be significant in the event of leverage.
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Unforeseen events can lead to variation in performance from the tested trading strategy.
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The tested result has been computed with price feeds available from Bloomberg.
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The testing environment has not considered transaction or any other costs.
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Trading indicators used for the purpose of testing has been provided by Bloomberg.
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The strategy might suffer from data mining fallacy, selection bias and backfill bias.

Data Source: Bloomberg
Prices as on 26th Apr, 2021

Arun Leslie John
Chief Market Analyst

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